El-Erian: Central Banks "Have Materially Damaged Their Standing"

The “branding” of modern central banking started in the United States in the early 1980’s under then-Federal Reserve Board Chairman Paul Volcker. Facing worrisomely high and debilitating inflation, Volcker declared war against it – and won. In delivering secular disinflation, he did more than change expectations and economic behavior. He also greatly enhanced the Fed’s standing among the general public, in financial markets, and in policy circles.

Volcker’s victory was institutionalized in legislation and practices that granted central banks greater autonomy and, in some cases, formal independence from long-standing political constraints. To many, central banks now stood for reliability and responsible power. Simply put, they could be trusted to do the right thing; and they delivered.

As any corporate executive will tell you, brands can be consequential drivers of behavior. In essence, a brand is a promise; and powerful brands deliver on their promise consistently – be it based on quality, price, or experience. In some cases, consumers have been known to act on the strength of brand alone, even purchasing a product with relatively limited knowledge about it.

Indeed, brands send signals that facilitate the task at hand. In some special cases – think of Apple, Berkshire Hathaway, Facebook, and Google – they have also acted as a significant catalyst for behavioral modification. In the process, they often insert a wedge that essentially disconnects fundamentals from pricing.

Building on Volcker’s success, Western central banks have used their brand to help maintain low and stable inflation. By signaling their intention to contain price pressures, they would alter inflation expectations – and thus essentially convince the public and the government to do the heavy lifting.

In the last few years, however, the threat of inflation has not been an issue. Instead, Western central banks have had to confront market failures, fragmented financial systems, clogged monetary-policy transmission mechanisms, and sluggish growth in output and employment. Facing greater challenges in delivering desired outcomes, they have essentially pushed both policies and their brand power to the limit.

This is apparent in central banks’ aggressive emphasis on communication and forward policy guidance. Both have been used more widely – indeed, taken to extreme levels – to supplement the unconventional expansion of balance sheets in the context of liquidity traps.

Now, corporate executives will also tell you that brand management is a tricky affair. It is particularly hard to maintain or control your brand when popular sentiment overshoots.

This is what happened to Apple’s stock this year. As brilliantly explained by Guy Kawasaki in his book on the company, the brand essentially created “enchantment.” Extrapolating this into a market view that Apple could not only innovate continuously, but also fend off any and all competitors, investors took the company’s share price to dizzying heights.

Elsewhere in California, Facebook found its brand fueling enormous hype for the company’s initial public offering. Encouraged by investor excitement and indications of over-subscription, underwriters hiked the IPO’s price well above what they had first deemed reasonable. Issuing the stock to the public at an inflated price a year ago, the shares initially traded even higher.

In both of these cases, and in many others, brand power did more than lead to price behavior that was disconnected from fundamentals; it also caused a dangerous overshoot, which, when subsequently reversed, damaged the brand.

However powerful, brands cannot divorce pricing from fundamentals entirely and forever. Accordingly, and despite a significant market rally that has taken many individual stocks to record highs, Apple and Facebook currently trade at almost half their record levels. Their dominance and influence are no longer unquestioned.

Western central bankers should spend some time reflecting on these experiences. Some have actively encouraged markets to take the prices of many financial assets to levels no longer warranted by fundamentals. Others have stood by passively. Indeed, it seems that only retiring central bankers, such as Meryvn King of the Bank of England, are willing to raise concerns publicly.

This behavior is understandable. Central bankers are basically hoping that financial-market hype by itself can help pull fundamentals higher. The idea is that price action will trigger both the “wealth effect” and “animal spirits,” thus inducing consumers to spend more and companies to invest in future capacity.

Count me among those who worry about this situation. Far from a world of optimal policy, central bankers have been forced into prolonged reliance on imperfect approaches. From my professional vantage point, I sense a mounting risk of collateral damage and unintended consequences.

Market signals are more distorted, fueling resource misallocations. Investors are piling on more risk at increasingly elevated prices. Fundamentals-based investing is giving way to a frantic search for relative bargains in an increasingly overpriced financial world.

All this will not matter much if central banks live up to their reputation as responsible and powerful institutions that deliver on their economic promises. But if they do not – essentially because they are not getting the required support from politicians and other policymakers – then the downside will involve more than just disappointed outcomes. They will have materially damaged their standing and, consequently, the future effectiveness of their policy stance.

By extending well beyond their comfort zone, today’s central banks face unusual brand-management risks. Their prior ability to deliver on promises and expectations has made today’s financial markets take the forward pricing of the economy to levels that exceed what central bankers alone can reasonably deliver.

The implication is not that central banks should immediately halt their hyper-activism and unconventional measures. It is that they should be much more open about the inherent limitations of their policy effectiveness in current circumstances.

Western central bankers need to become much more vocal and, one hopes, more persuasive in placing pressure on politicians and other policymakers. Otherwise, risking major brand damage, they will end up adding yet another item to an already-overloaded plate of challenges for the next generation.

El-Erian says if CBs don't deliver on their promises (I believe we were promised 'price stability' and 'full employment'): "then the downside will involve more than just disappointed outcomes."

Heads will roll? What I don't like is that Mo is telling us to read between the line. He doesn't admit that CBs aren't incompetent, they are following the exact policy that is good for their masters. There are going to be dire consequences when that fact dawns on the populace.

what you have is a no way out slow burn trap, the CB's know this and are arranging the deck chairs in a coordinated fashion with geopolitical masters. When they all have their ducks in a row the trap door < on us > will close quick and hard. The masses will have to be cornered and pacified quickly and brutally so the 1% can gain full control of the herd post reset.

Shitheads indeed. ZIRP has been so good for eveyone, NIRP is going to be killer. The capital and resource mis-allocation and mal-investment continues. Please, the "growth" meme requires growth in expendable eneergy, unfortunate infinite growth in a finite world does not work. Prepare for war.

"Hi guys, you may remember me on ZH for my permabullish and pro-Fed trading perspective. I have decided to finally realize all of my 4,567% capital gains from my keeping long leveraged positions on my high-beta cult consumer stocks like LULU, and NFLX and retire in a secluded villa overlooking the north coast of Malibu. Hope you guys are doing well, and if you are in the neighborhood, drop by. Thank you Helicopter Ben. Signed, Robotrader."

We're in the third period of economic history in the USA since 1900. The first was oil consumption rising 6-7% per year until 1970 or so. Then came the fiat era with total debt rising much faster than GDP. Now it's the ZIRP/QE era, which may last a while. What's next? You don't want to know.

"Western central banks have used their brand to help Hide rising and unstable inflation. By signaling their intention to suppress price pressures, they would alter inflation optics – and thus essentially convince the public and the taxpayer to do the heavy lifting.

As long as we have a perpetual debt monetary creation system doesn't matter what the Central Banks do. The end is going to be the same and that is economic destruction of whole countries when the confidence is gone in the currency, the banks only function really is to try to keep that confidence intact but the free spending governments will ultimately undercut any of their actions. Debt free, hard asset backed money with no rehypothecation on the actual money supply is the only solution to rebuild a solid foundation only all levels of the economy. Everything else is just putting off the inevitable. Mathematical fundamentals that are tried and true and proven logically through proofs will not be denied no matter what any expert may say.

People want their cake and eat it too. Business cycles are *cycles*... up and down. You can't expect up up up up all the time. But that's what the Fed (and the common sheep) want - to our own destruction.

The fed never ever "beat inflation" and managed inflation expectations lower. Consider the inflation you never saw. For example...Who used to pump your gas and who does it now? Who used to bag your groceries and who does it now? Who used to book your travels and who does it now? The illusion is that the fed managed inflation away. The truth is people took cost measures in their own hands as the dollar's buying power continued to be printed away. The fed has done nothing but butcher the buying power of the FRN. Lying bag of shit.

Hidden inflation of every kind. Chip bags from 8 oz to 7 oz then 6 oz. Price, the same. Inflation 0%. Or is that 25%?

Sausage at the grocery store is now inedible, haven't even tried in 3 years, after they surreptitiously changed the recipe. Likely more bread crumbs (or even better, cellulose) and less meat.

Coke was 24 in a flat, now 20. Same price. So basically, ingredients are being downgraded, esp. high quality, costly ingredients (the meat part of the sausage). Product sizes are being reduced with prices staying the same (not possible in wholelsale). And then the 'self-service' measures you discuss. And on top of that, prices are still going to keep going up!

Zero Hedge has now jumped the shark of 'PRECRIME THOUGHT POLICE'... My comment regarding the disambiguation of the myriad of alternatives of the term 'clownbux' now, officially, gets your comment deleted on this blog...

Which also got dick cheney's ghost comment deleted as well [just for saying "nice to see you"]...

Hey El Erian! Fuck you! Fed policies are destroying the world you wall street whore. You pussy. And you want to use your professorial marketing language and talk about how they are "damaging their brand."

How about having their heads on a fucking stick and yours too you chickshit?

What's the next step when a fiat currency's "brand" is damaged? Diversification, then dumping, accelerating velocity, hyperinflation. You can try to hide the beginning stages by selling your (or somebody's) gold, or leveraged imaginary gold, but demands for physical delivery put a limit on that game.

El-Erian's call for federal legislative and policy support means . . . more spending? It is absurd to think anyone could count on politicians to take responsible action such as cutting unnecessary spending. So, I must assume El-Erian is suggesting that the Obamites be given free reign to spend our way to utopia.

I think the author, should understand what his "new normal" means . . . this fiasco has been going on for almost six years and each day Bomber Ben keeps the printing presses running . . . this is the new normal.

We are the muppets that are being manipulated and now most of the sheeple seem to believe the worst is over . . . it has yet to begin.

The only protection anyone can muster in a time like this (pre great, great depression), is to liquidate debt, and put cash into "hard assets" not pieces of paper which can be manipulated by flash traders.

Find a piece of land and work on preparing it so that you can survive what is coming to our world there.

I am a farmer, I never owned a stock, I always believed that I could lose my money as well as those who farm the muppets can. I only own farmland and I lived through and lost land in the farm depression of the 80's when Volker raised interest rates to 17%.

That lost land was replaced during the land value crash that followed in the late 80's. Today, many call farmers in Iowa lucky, where a mere 80 acres will now make one a millionaire, but most of us paid a harsh price and learned a life long lesson regarding "leverage" during that era when we were Volkerized.

So be good to yourself, most will survive this attempt by our government to make peons out of us. But put your money in something that will still be there when the dust clears from the hard times that lay ahead.

Many Americans are suffering right now, and it is just beginning. Adios Amigos. John